Fitch downgrades Portugal with negative outlook

Fitch Ratings has downgraded Portugal’s long term foreign and local currency issuer ratings to ‘BB+’ from ‘BBB-‘ and short-term rating to ‘B’ from ‘F3’ with a negative outlook.

“The country’s large fiscal imbalances, high indebtedness across all sectors and adverse macroeconomic outlook mean the sovereign’s credit profile is no longer consistent with an investment-grade rating,” the agency said.
The agency has lowered Portugal’s growth forecasts in light of the worsened European outlook. Gross domestic product is expected to contract by 3% in 2012, but “significant structural reforms should leave Portugal in a more competitive position in the long term,” it said.

Over the next two years, the recession will make the government’s deficit-reduction plan much more challenging and will negatively impact bank asset quality. The agency said it believes the government’s commitment to reforms to be strong.

The official deficit target of 5.9% is expected to be met this year, though with the help of one-off measures. The most significant of these will be the transfer of bank pension schemes to the public sector, booking an upfront gain of up to 1.7% of GDP.

The 2012 budget contains significant expenditure reductions, mainly on pensions and civil service pay. The budget is well-designed and is based on reasonable GDP assumptions and the agency said it expects the 4.5% deficit target for 2012 to be met.

There is a big risk of slippage, either from worse macroeconomic outturns or insufficient expenditure control. Given these downside risks, Fitch sees a significant likelihood that further consolidation measures will be needed in 2012.

The sovereign crisis poses significant risks to the banking system, which lends to one of the most indebted private sectors in Europe and is highly reliant on wholesale financing, access to which is now closed off, the agency said. Recapitalisation and increased emergency liquidity provision from the European Central Bank to Portugal’s banks will be needed and provided, it said.

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